Liquidation causes all creditors to “come together” so that they, in a certain order, can share collectively in the proceeds of the assets of the entity that is liquidated.
Liquidation can be a wonderful thing at the right time, but since a loan account is also an asset in the entity, it can cause a problem for any director/member. It often stops persons from liquidating a business that desperately needs to be liquidation.
During the course of a business, it is an excellent tax avoidance method to put drawings of directors/members against a loan account. Very legitimate and really good while it lasts, but then it bites a director/member when there is a liquidation, because now that very loan account that saved one so much on taxes, is now a burden which can have a serious financial effect on a director/member.
Of course, since a loan account is an asset in the business, the loan account will be called up by the liquidator. I have seen very big loan accounts of millions and of course, if that is the case, it either renders it impossible to liquidate the entity or the director/member will have to sequestrate as well for protection.
If there is a liquidation, there are ways to deal with loan account so that it does not become an amount that must be repaid to the liquidator after liquidation:
Reverse the full amount to a salary so that the director/member can pay income tax on the amount. If the amount is not too high, and the income tax will be affordable, this may be the cheaper option as the director/member then does not have to repay the full loan.
The company can declare a dividend and pay 20% dividend tax on the amount. (I am no accountant, but this is what I have learnt through the years of dealing with liquidations). I cannot give you a lesson on how to do this, but I am certain that an accountant or auditor will understand what I mean.
Also, if the member/director paid any expenses of the business out of his private account, deduct these expenses from the loan outstanding and put the expense amounts to the business. This will reduce the loan.
There are other methods to reduce or get rid of the loan in legitimate ways and I know that a good tax expert will be able to advise better on this.
Liquidation is therefore not the end of the world if there is a loan account. The purpose of this article is purely to open the door to alternatives in dealing with a loan account in a liquidation and with strategic thinking and accounting principles, the client can be assisted to liquidate an entity with a loan account.
Article written by Nanika Prinsloo of Prinsloo & Associates Attorneys. Email firstname.lastname@example.org